Gold had a tough
December, falling 10.5% to grind along near its worst levels since
July. This sparked hyper-bearish sentiment and
end-of-gold’s-secular-bull talk. Naturally gold stocks fared even
worse in this rampant gold pessimism, with the flagship HUI
gold-stock index plunging 14.7%. But this selling was radically
overdone, as compared to gold’s absolute levels gold stocks remain
incredibly cheap.

Gold stocks, of
course, are in the business of mining gold. Since the costs for
mining a particular gold deposit are largely fixed during that
mine’s planning stage, higher gold prices generally translate
directly into higher profits. And universally in all sectors of the
stock markets, higher profits lead to higher stock prices.
Ultimately every stock is merely a fractional stake in its
underlying company’s future profits stream. So higher profits and
future profits potential entice investors to buy into and bid up any
stock.

At Zeal we’ve done
a lot of work looking at gold-mining profits over the past decade or
so. During a
secular gold bull, which we have enjoyed since April 2001, gold
rises on balance. Global demand for this metal grows faster than
global supplies, so competition for this scarce and desired resource
drives higher prices. And despite higher mining costs driven by
inflation and other commodities’ bull markets, both absolute profits
and profit margins
have continued expanding greatly throughout this gold bull.

The gold price
truly is the overwhelming primary fundamental driver of gold-stock
valuations and therefore gold-stock prices. So when gold stocks get
too cheap relative to the metal they mine, it is time to buy low.
And later when they grow popular and get too expensive relative to
gold, it is time to sell high. This relationship is easiest to
capture with the HUI/Gold Ratio. The HGR simply divides the closes
in this leading gold-stock index by the price of gold, and charts
the results over time.

And as you can see
in this secular HGR chart, gold stocks are about as cheap today as
they’ve been throughout this entire gold bull. The only exception
was the crazy stock panic in late 2008 and its immediate aftermath,
which was very short-lived. The HGR is rendered in blue off the
right axis, superimposed over the raw HUI itself in red on the left
axis for comparison. Gold stocks are dirt-cheap!

As of the middle
of this first week of the new year, the HUI closed at 521 while gold
was running $1612. This yields a HUI/Gold Ratio of 0.32x. This
information in isolation is useless, but seen in the context of this
gold bull it is very illuminating. As this chart reveals, the HGR
is now back near levels only seen during the stock panic. Gold
stocks are almost as cheap relative to gold today as they’ve been
throughout its entire secular bull!

Obviously the
first true stock panic
in 101 years
was an epic discontinuity, the greatest super-storm of fear we will
see in our lifetimes. Commodities, including safe-haven
gold, were hit
exceptionally hard. Investors and speculators alike literally
panicked, selling everything they could at any price they could
get as they stampeded for the exits. A sizable fraction of traders
couldn’t handle this extreme stress and the losses they incurred by
succumbing to their own fear, so they capitulated to never return to
the markets.

But before that
crazy event, the HGR had traded in a tight secular trading range
for 5 solid years. The gold-stock valuations as measured by
this ratio usually meandered between 0.46x support and 0.56x
resistance. When the HGR was low in this range, it was time to buy
gold stocks cheap. When it was high, it was time to sell and
capitalize on their rich prices. The 5-year pre-panic average HGR
was 0.511x. In other words, the HUI tended to trade at about
half the price of gold.

Even though gold
fell precipitously during the stock panic, down 27.2% in just under
4 months, the HUI fared much worse. At worst within that same span,
it plummeted an absurd 67.7% in less than 3.5 months! Hence the
apocalyptic plunge in the HGR in late 2008 on this chart. The gold
stocks got so insanely oversold relative to gold that the HGR hit
its worst levels of this entire secular gold bull.

I wrote about how
ridiculous this was at the time, so we bought gold stocks
aggressively in the dark heart of the panic despite the extreme
fear. And we were richly rewarded for this stubborn contrarianism,
logically forcing ourselves to be brave when everyone else was
afraid. On October 28th, 2008, the day after the HUI’s panic low, I
told our Zeal Speculator subscribers…

“Yet the HUI
closed near 152 yesterday, which is end-of-the-world levels as far
as I am concerned. This index hasn’t been this low since mid-2003!
Where was gold trading back then? In the $350s! Is this madness
or what? We have a gold price over twice as high yet stock prices
are apparently discounting mid-2003 gold levels. This is clearly
not rational and reflects the sentimental nature of this stock
selloff.”

At the time I
figured the HGR would eventually regain its pre-panic secular
trading range. After all, if a secular fundamental trend
holds strong for 5 years running, should a mere short-lived
psychological event permanently break it? Unfortunately, far
more former gold-stock traders simply gave up forever because of
that panic than I could have imagined at the time. Still though,
gold stocks were super-cheap and crazy-oversold so they did indeed
surge sharply in a fast initial recovery.

By December 2009,
despite losing 2/3rds of its value in the stock panic, the HUI had
nearly regained its best pre-panic levels. This once-beleaguered
gold-stock sector had more than tripled with a massive 236.9%
gain in about 13 months! But despite this fantastic and
hugely-profitable progress, the HGR had still stalled out in late
2009. While the gold stocks were still rallying, they weren’t
advancing as fast as gold.

This was troubling
back then, and is still troubling today. My business partner Scott
Wright and I have spent endless hours discussing whether or not the
former constituency of gold-stock shareholders from the pre-panic
days will ever fully return. They might not. But even if they
don’t, great quantities of new capital should easily dwarf
what was invested in gold stocks prior to the panic. Given the
incredible profit fundamentals of gold mining during a secular bull,
gold stocks can’t stay excessively cheap for long.

While the HUI
forged ahead to new all-time highs in 2010 and 2011, the HGR
continued to remain weak before collapsing last summer. For
extraordinary reasons likely never to be repeated, primarily the
first USA credit downgrade in our nation’s history, gold rocketed
higher last summer to
very-overbought
levels. But the gold stocks lagged far behind, to their credit
gold-stock investors were skeptical of the staying power of gold’s
blisteringly-fast advance. So the HGR started collapsing despite
all-time-record gold prices.

Unfortunately even
though the gold stocks had failed to leverage last summer’s wild
gold rally, they still leveraged its downside when gold’s inevitable
overdue correction arrived. So the HGR continued to drift lower.
By early October it was back down to levels only seen before
surrounding the stock panic. And obviously in hindsight given the
HUI’s gigantic 2009 recovery rally, those lows were an unsustainable
anomaly as I told our subscribers as they occurred.

If an HGR in the
low 0.30s wasn’t sustainable during that extreme fear maelstrom of
late 2008 and early 2009, why on earth should it be sustainable in
the far-more-normal markets of recent months? Even if you are
skeptical that the HUI can ever return to its pre-panic average HGR,
today the gold stocks are super-cheap even by their pathetic
post-panic standards. Today we are blessed with one of the best
gold-stock buying ops of this entire secular gold bull.

This next chart
zooms in to this post-panic period. The same HGR and raw HUI data
from above are included, along with an additional series in yellow.
It shows a hypothetical HUI at that secular pre-panic average HGR of
0.511x. It is roughly where the HUI probably would be
trading if the stock panic hadn’t scared such a large fraction of
the early gold-stock investors away from this high-flying sector.

After its fast
initial recovery out of those secular-bull lows, the HGR started
rising in a nice new uptrend. This continued until spring 2011,
with the gold stocks essentially basing high (in post-panic context)
relative to gold. But then this uptrend’s support failed as gold
continued powering to new secular-bull highs while the gold stocks
refused to follow. This collapse eventually dragged the HGR back
down to March 2009 secondary-panic-low levels that persist today.

In addition to the
HGR itself, there is an alternative way to measure how the benchmark
major-gold-stock index is faring compared to gold. It looks at
where the actual HUI is trading compared to where that
hypothetical HUI at the 0.511x pre-panic average HGR would be
trading at. Expressed as a percentage, this metric is shown above
at some key highs and lows in the HUI’s post-panic uptrend.

Way back in April
2009, just emerging out of those secondary stock-panic lows about a
month earlier, the actual HUI was merely trading at 62% of where the
hypo HUI would have been. But as the far-more-oversold gold stocks
recovered faster than gold, this gradually recovered to 82% by
December 2009. Then for the next year and a quarter or so, this
metric generally improved. It would run between the high 60s to low
70s at major gold-stock lows to the low 80s at major highs.

But the horrendous
gold-stock performance relative to gold in much of 2011 scuttled
this HGR recovery. In the past few quarters, the actual HUI has
only traded at 67% of where the hypo HUI would be at best.
And at HUI lows it has slumped back down to the low 60s again, and
even hit 61% as recently as late December. Once again these levels
were way too cheap to be sustainable after the panic, and are almost
certainly way too cheap to be sustainable today.

Even if you don’t
think the HGR will ever claw back up into that pre-panic range,
simply consider its post-panic one. It has traveled between roughly
0.31x on the low side, where we were recently, to 0.43x on the high
side back in late 2009. But let’s be conservative and just call
resistance 0.40x, a level exceeded in both 2010 and 2011 as well
when the gold stocks were near interim highs. At $1600 gold and a
0.40x HGR, the HUI would be trading at 640. This is almost 25%
higher than where it was trading this week!

And believe it or
not, that pre-panic average HGR is certainly attainable again. And
given the incredible fundamental profit dynamics of mining gold in a
secular gold bull, I suspect it will be. Investors ultimately chase
profits and future profits potential, which gold stocks have in
spades. The best investors in the world are sector-agnostic, they
will buy wherever stocks are cheapest relative to profits. The
great potential in gold-stock profits going forward should attract
in tons of new capital, forcing the HGR higher.

Provocatively,
back in early 2009 I made a similar case about the
Silver/Gold Ratio.
Silver, being far more speculative than gold, was hit much harder
during the stock panic. It also had something of a pre-panic
trading range relative to gold, its primary driver. I argued then,
and subsequently,
that silver would not only return to its pre-panic average but
exceed it. Like this HGR analysis, traders thought I was nuts
for believing silver would ever be as valuable relative to gold
again.

But not
surprisingly, starting in late 2010 as silver really caught favor
with speculators again, it soared higher far faster than gold. Not
only did the SGR hit its pre-panic average, but it rocketed much
higher to achieve its best levels by far of this entire secular
bull! This recent SGR example is a great lesson in never
underestimating the power of mean reversions to restore a secular
fundamental relationship after sentiment knocks it out of place.

At its old 5-year
pre-panic average HGR of 0.511x and today’s $1600 gold price,
the HUI would be trading near 818. This is 57% higher than where it
was trading this week! Yes, the major gold stocks could rally 50%+
from here and still merely be valued at average levels
relative to the metal that drives their profits. And I still
believe, despite the tough post-panic slog, that the HUI logically
ought to regain its old pre-panic secular ratio with gold.
Fundamentals always ultimately triumph.

And as I always
point out in this type of secular ratio analysis, these numbers all
assume gold stays flat. As gold’s secular bull continues
powering higher, the rising denominator in the HGR pulls up the HUI
targets. And remember that the HUI is comprised of the giant gold
stocks, which have a lot of inertia due to their large market
capitalizations. The smaller gold stocks, especially the
left-for-dead
juniors, should really leverage a move by the HUI to regain more
reasonable fundamental levels relative to gold.

And despite all
the rampant bearishness gold’s healthy correction spawned, its
secular bull is far from over. All over the world, fiat-paper money
supplies are growing at 7% to 8% annual rates. Last year in the US,
the Fed grew our own broad money supply (MZM) by 9.4%. The euro is
being inflated too, which it has to be given the eurozone countries’
excessive debt loads. But meanwhile, the global above-ground gold
supply continues to grow at its meager historical average of
around 1% a year. Such slow growth has helped make gold
history’s ultimate money.

With the world’s
supply of paper money that can bid for gold soaring 7x to 8x as
fast as the gold supply itself, how can this metal not be driven
higher? Gold is the primary financial asset of refuge in
inflationary times, and the world’s central banks are inflating with
a vengeance to lessen their countries’ debt burdens. And if gold
remains popular and continues to power higher in its secular bull,
you can be sure that gold stocks will inevitably return to favor
sooner or later.

Very fortuitously
given how cheap gold stocks are now, we just finished our latest
deep-research project. We spent several months looking at the
entire universe of junior gold producers trading in the US
and Canada. We painstakingly whittled down around 100 to our dozen
favorites, the elites with the most-promising fundamentals. Then we
profiled each of these in a fascinating new 34-page
fundamental report,
now available on our website. It is just $95 ($75 for subscribers),
a steal for the fruits of hundreds of hours of expert world-class
research. Buy yours
today while junior golds remain incredibly cheap!

We also publish
acclaimed weekly
and monthly
subscription newsletters. In them I draw on our vast experience,
knowledge, wisdom, and ongoing research to explain what the markets
are doing, why, and how to trade them with specific stock trades as
opportunities arise. Our bold contrarian approach since 2001 has
yielded a stellar track record. All 598
stock trades
recommended in our subscription newsletters have averaged annualized
realized gains of +48%!
Subscribe today
and start thriving!

The bottom line is
gold stocks are very cheap relative to gold today. This is true
both in pre-panic and post-panic context. The gold stocks have been
so unloved in recent months that they were languishing near lows
last seen emerging out of the stock panic in early 2009. And just
as those low valuations were unsustainable then, they are
unsustainable now. Gold stock prices, like all stock prices, will
eventually reflect their underlying profit fundamentals.

While it is
challenging psychologically to buy any sector when it is out of
favor, that’s the only way to earn big money in the stock markets.
Contrarians know the only times prices are low is when others are
scared, so they have to suck it up and be brave. And with gold
stocks recently trading near late-panic extremes because the
necessary gold correction scared people, there has rarely been a
better buy-low opportunity.